CEO’s Legal Lament

On more than one occasion lately, I have had conversations with CEOs who vented their frustration about trying to run a business in the current legal environment, for which at times I am held personally responsible. They usually note, of course, the evident culture gap between their strong pragmatic bent and my detached academic approach. But some are eventually surprised to figure out that the differences in language and attitude don’t keep us from coming to the same conclusion. So, what drives our joint state of dissatisfaction about the business climate in the U.S.?

CEOs lament (but only in private) that government officials high and low can’t make up their minds and stick to a program.The constant to and fro, the unexplained shifts in position and the dogged refusal to sign off on any project combine to make life miserable for business leaders and their professional staffs. Businesses can turn somersaults if they know the rules of the game. But it is hard to commit to billion-dollar projects when the rug can be pulled out from under you.Business needs to run its own show. Academics should help lawmakers structure the game that businesses have to play.

Our differences in approach don’t look so large if we remember Adam Smith’s “invisible hand.” In a competitive market, just rely on the forces of supply and demand. Smith’s genius was to figure out that the person who tries to better his own position in that environment neither intends to promote the public interest nor knows how much he is promoting it.Nonetheless he is “led by an invisible hand to promote an end that was no part of his intention.” So if government sets the right rules, the forces of self-interest will do the rest. And if they don’t…

A Deadly Combo

At this point, the real objection is that government at all levels does not know how to set the right rules. Often, it never sets any rules at all. Exhibit A is the destructive synergy between administrative regulations on the one hand and tort liability on the other, regarding key questions of product design and product warnings. Take it as a given that any wellrun business can meet the highest standards of quality control. Production errors can be kept to levels of one in a billion or lower. Keeping contaminated drugs and rusty steel off the market are vital functions that firms can handle.

But design and warning issues can break many firms. Government agencies set design standards for cars or appliances and warning standards for drugs and chemicals. Setting these standards often involves extensive and expensive administrative hearings in which government bureaucrats know less about the relevant science than the industry experts who appear before them.

The government’s own evaluation of the Food and Drug Administration (FDA), for example, laments that the FDA’s hard- pressed scientists are not familiar with the advanced techniques and protocols developed by the scientists who sit across the table. The FDA’s shakiness on the science translates into procedural nervousness and a call for more theoretical documentation, more detailed biomedical experiments and longer clinical trials. Delay becomes the tool of choice for government officials, who take all the heat for products that fail and get no credit for the innovations that succeed. That bunker mentality drives up out-of-pocket costs and increases the risk that a sound product will be left in regulatory limbo until endless procedural hurdles can be overcome. Not good for innovation.

Unfortunately, it gets worse. Once a new drug or fungicide receives approval it can only be marketed with a detailed set of warnings or instructions either prepared or reviewed by government officials, who are usually excessively cautious in their risk evaluations. But once these products hit the marketplace bad things always happen, if only because too many people think that warnings and instructions are only for the other guy. To the sensible CEO, the response to all these cases is, “Just tell us what you want us to say. If we disagree, we can hash it out and come to some sensible compromise.”The tort law, however, shows no respect for these administrative deliberations. It treats FDA and EPA warnings as mere minimums that any jury can find inadequate after the fact, so as to hit the manufacturer with huge damage awards for losses brought about by the misconduct of key downstream actors like physicians or plant safety supervisors or just plain bad luck. These jury escapades only compound the risks from administrative delay and timidity.

Not surprisingly, the whole system starts to unravel because the ingrained conceit is that judge and jury are fully competent to act as a council of revision on product safety. It’s easy to say that something is inadequate. It is a lot harder for any jury to draft a bulletproof substitute warning and instruction—that is, one that supplies an airtight defense to all of the countless challenges that may come. Ditto with respect to the design of automobiles or electrical equipment.

Quite simply, local juries are the wrong instrument for setting national safety standards. Swayed by idiosyncratic circumstances, they often reach inconsistent outcomes on critical choices of design or warning adequacy. Frequently, hindsight rules their judgment. So if a car is hit in the side, strengthen the side panel. If it rolls over, demand a stronger roof. Each change looks vaguely sensible in isolation, but put them together and a car slowly becomes a tank. In contrast, the federal administrators in the National Highway Traffic Safety Administration work from the ex ante perspective, and thus are not caught in this piecemeal trap. Their requirements may be less than ideal, but they are not as perverse as the sum of separate jury verdicts, which taken together give a manufacturer zero information as to how to build new products for the future. State courts soft-pedal their role by saying that they are “merely” telling manufacturers to make reasonable products. Federal judges compound the problem by refusing to hold that federal warning and design standards trump the jury determinations that seek to set national standards. If put to the test, most CEOs would take dumb government regulation over ad hoc jury determinations in a heartbeat.

Permits Forever

The CEO love for the administrative state is hardly unconditional. After all, the permit process can become a nightmare even in the absence of exposure to tort liability. Real estate permits tell the story. Edward Glaeser of Harvard’s Department of Economics did an instructive study to locate the source of huge price differentials in residential real estate. Usually that difference is not in the cost of land. Nor is it in the cost of construction. Rather, it is the difference in permitting costs. Places that want new construction can zip through the process. Those that don’t can tie new construction up in knots for years.

That pathology has three critical symptoms. First, the standards for granting or denying individual permits are often vague. How does anyone decide whether architecture is “compatible” with the neighborhood, which already has lots of different styles? Second, the permit process is interminable. For example, New York City’s Uniform Land Use Review Procedure has five independent stages of review, with stops at the community, borough, city planning commission, city council and mayoral level for review. Full permitting is a game of Chutes and Ladders. One false step and you are back to square one.

Third, permitting is a multifront war. Separate permits, from different levels of government, are needed to handle zoning, vehicular access, construction, safety, handicap access, utility hookups, emissions, poverty and more. Each permit authority acts like the only game in town, and doesn’t consider how each change in its rulings throws the other applications into turmoil. This endless back and forth costs time and money. Sensible projects are put on hold, and older buildings are stretched beyond their capacity. The best becomes the enemy of the good. We get what we pay for: more useless files and fewer useful buildings.

A Fresh Start

So what is the cure? The root of the problem is not legal. Part of it stems from the peculiar culture of public distrust toward business, which in turn leads to unwarranted faith in administrators and juries alike. In addition, that process is stoked by bad competitive motivations from within the business community. The company whose project is underway gets a stronger position by helping raise regulatory obstacles to its future competitors.

And the cure? Some steps seem clear, even if they only scratch the surface. The first step is to expose the deep error in thinking that more regulation and tort liability combined spells more safety and higher consumer satisfaction. The second step is to cut the red tape. Remove the risk that jury verdicts can undermine administrative findings that apply to health and safety. Injured persons can sue—to their heart’s content— firms that don’t play by the rules of the game. But they cannot touch those that do.

Reining in the permit process is a tougher task, but one sensible first step is to insist on final decisions up or down within, say, six months, after which there is prompt judicial review, with this caveat: The agency that loses can’t start the process over again. There is a lot more to be said. Even so, these sensible operational fixes should appeal equally to CEOs who have to run the maze and to academics who want to help design the best possible maze.

Richard A. Epsteinis the James Parker Hall Distinguished Service Professor of Law, the University of Chicago, and the Peter and Kirsten Bedford Senior Fellow, The Hoover Institution. He has consulted for employer groups on EFCA.

About richard a. epstein

Richard A. Epstein is the Laurence A. Tisch Professor of Law, New York University, the Peter and Kirsten Senior Fellow, The Hoover Institution, and a senior lecturer and the James Parker Hall Distinguished Service Professor of Law Emeritus at the University of Chicago. He is a recipient of the 2011 Bradley Prize. He writes extensively on topics of business and labor, property rights, health care, and liability.